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March 2, 2007 No. 2007-09
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Ontario/Federal Corporate Tax Harmonization — Get Ready for the Transition
Corporations subject to tax in Ontario should be aware that the Ontario and federal governments signed a new tax collection agreement on October 6, 2006, under which the federal government will administer Ontario's corporate tax system, along with collecting the tax. The agreement will allow Ontario businesses to make combined payments and file a single corporate tax return for taxation years ending after 2008. To facilitate this change, Ontario has agreed to harmonize its corporate income tax base with the federal one. Under the federal/Ontario agreement, the CRA will also administer Ontario’s corporate capital tax and corporate minimum tax.
Ontario introduced Bill 174 on December 13, 2006 to implement these measures, including most of the transitional rules that will affect Ontario busi nesses’ tax filing practices. This TaxNewsFlash-Canada summarizes and discusses the tax and accounting implications of these transitional rules.
Why are transitional rules needed? Currently, the federal government and Ontario do not share a common corporate tax base. Accordingly, a corporate taxpayer can have different tax attributes or balances such as undepreciated capital cost allowance, tax losses and other pools, and discretionary deductions in each jurisdiction. Under the federal/Ontario agreement, corporations will use federal tax attributes as the common tax base for taxation years ending after 2008. Without transitional rules, the use of federal tax attributes could cause Ontario corporations to understate or overstate their income tax liabilities.
Transitional rules for tax base harmonization
Calculation of transitional debit or credit As a first step in the transition, a corporation must compare its federal tax attributes with its Ontario tax attributes at the transition time and address the difference according to the transitional rules. A corporation’s transition time occurs on the first day of its taxation year that ends in 2009. Thus, depending on a corporation’s year-end, the transition time could occur early in 2008.
Generally, a corporation’s liability or relief under the transitional rules would be determined using a temporary five-year tax credit or tax debit mechanism. This credit/debit would normally be determined for each taxation year ending after 2008 and before 2014 by multiplying the Ontario excess/federal excess by the product of:
· The Ontario basic corporate income tax rate (currently 14%) · The percentage of the corporation’s taxable income allocated to Ontario under federal rules · The percentage that the number of days in the taxation year included in the corporation’s “amortization period” is to the total number of days in the corporation’s amortization period.
A corporation’s amortization period would normally start at the beginning of a corporation’s first taxation year ending after 2008 and end five calendar years afterwards. Thus, the percentage would typically be 20% per annum.
A transitional credit will not be refundable. If the transitional credit for a taxation year cannot be fully used, the unused portion can be carried forward only to subsequent taxation years in the amortization period.
Example of transitional rules Consider an Ontario corporation with 100% income allocation to Ontario (OnCo1) that has an undepreciated capital cost balance (UCC) for federal tax purposes of $100 million and Ontario UCC of $70 million on January 1, 2009. Assume all other tax attributes are the same. The use of the federal UCC pool as of January 1, 2009 would result in a $30 million gain in future Ontario tax deductions for OnCo1 for Ontario tax purposes.
With a $30 million excess of federal tax attributes over Ontario tax attributes, OnCo1 would have an Ontario tax debit of $4.2 million ($30 million × 14%), which would be amortized over five years to increase Ontario tax payable at 20% or $840,000 per annum.
If another Ontario company (OnCo2) has UCC for federal tax purposes of $70 million compared to $100 million UCC for Ontario purposes on January 1, 2009 (and no other differences in its tax attributes), then OnCo2 would suffer a $30 million loss in future Ontario tax deductions with the adoption of federal UCC attributes.
With a $30 million excess of Ontario tax attributes over federal tax attributes, OnCo2 would be entitled to an Ontario tax credit of $4.2 million ($30 million × 14%), which would be amortized over five years to reduce Ontario tax payable at 20% or $840,000 per annum.
Accounting for tax considerations
Impact of transitional rules on financial statements
Despite being “substantively enacted” for Canadian GAAP purposes as of December 13, 2006, the transitional rules would not, in our view, affect the tax provisions in the financial statements until interim and annual periods ending after December 31, 2008. However, financial statement disclosure might be required based on the facts and circumstances of the taxpayer, starting with financial statements ended on or after December 13, 2006. Future modification or clarification issued by the Canadian Institute of Chartered Accountants could take a contrary view of this accounting for income tax issue.
Since the proposed rules provide for the use of federal tax attributes, a separate calculation of future income taxes, normally required for each tax jurisdiction (i.e., federal and provincial) where the tax bases of assets and liabilities are different, would not be required after 2008 for Ontario because the tax attributes for both the Ontario and federal jurisdictions will be the same. As such, the harmonization of Ontario and federal corporate income taxes should ultimately simplify the calculation of future income taxes.
Financial statement classification of transitional credits and
debits
Example of accounting treatment In the example above in which OnCo1 has $30 million of excess federal tax attributes over Ontario tax attributes, the transitional tax debit represents additional Ontario taxes that are payable over five years at 20% per year. Since the transitional tax debit will result in Ontario taxes payable in a future period, it should be classified as an income tax liability on the balance sheet. The portion of the transitional amount that is not payable within one year from the date of the balance sheet should be classified as a non-current income tax liability.
Assuming that the carrying amount of the fixed assets of OnCo1 was $150 million as of January 1, 2009, the related future tax liability would be reduced from $11.2 million (($150 million - $70 million) x 14%) to $7 million (($150 million - $100 million) x 14%) — a reduction of $4.2 million. In this case, absent the interaction of other temporary differences, the current tax expense and future tax recovery would offset each other and the net impact to the income statement at the transition time would be nil.
In the second example above in which OnCo2 has $30 million of excess Ontario tax attributes over federal tax attributes, the transitional tax credit represents an Ontario tax credit that is amortized over five years to reduce future Ontario taxes payable. The transitional tax credit is an unused income tax reduction carryforward, which is a future tax asset and should be classified as such on the balance sheet. That portion of the credit that is not expected to reverse within one year of the date of the balance sheet should be classified as a non-current future tax asset. As with all future tax assets, normal valuation allowance considerations would need to be evaluated.
Assuming that the carrying amount of the fixed assets of OnCo2 is $150 million as of January 1, 2009, the related future tax liability would increase from $7 million (($150 million - $100 million) x 14%) to $11.2 million (($150 million - $70 million) x 14%) — an increase of $4.2 million. Absent interaction of other temporary differences or a need for valuation allowance on the transitional credit carryforward amount, the current tax recovery and future tax expense would offset each other and the net impact to the income statement at the transition time would be nil.
Special transitional rules
No further change to the debit/credit amount For simplicity, tax attribute balances will not be affected by subsequent events. For example, acquisitions of control or dispositions of property after the transition time will not change the calculation of the tax attribute balances.
Amalgamation and wind-up continuation rules Because of the transitional credits/debits, the draft rules propose that a successor corporation formed by an amalgamation during the amortization period be treated as a continuation of each of its predecessor corporations, subject to certain restrictions.
Similar rules would also apply to wind-ups of certain subsidiary corporations.
Anti-avoidance rule — Acceleration of transitional debits Normally, the transitional debits would be payable by a corporation over five years. However, subject to the continuation rules for amalgamations and wind-ups described above, it is proposed that the transitional debits be accelerated if certain transactions or events occur (i.e., "acceleration transactions").
An acceleration transaction could occur on the transfer of assets to a corporation intended to influence the Ontario allocation factor. If a party to a tainting transaction has a federal excess, its debits will be accelerated so that they are payable for the taxation year in which the transaction occurred.
Other corporate income tax issues
No add-back for management fees
New Ontario tax credit for R&D expenses
Harmonization of other Ontario corporate taxes
Ontario capital tax
It is important to note the differences between the LCT and the current Ontario capital tax system. For example, the LCT rules for computing a corporation’s paid-up capital do not provide for any adjustment to the paid-up capital for differences between the net book value of assets and their tax value, as required under the current Ontario capital tax regime. Further, the investment allowance calculation for LCT purposes is not prorated over total assets, as under the current Ontario capital tax regime.
Ontario’s capital tax rules for financial institutions, which are generally harmonized with the LCT rules already, will continue to apply after 2008 and will be administered by the CRA.
Ontario corporate minimum tax
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Information is current to March 1, 2007. The information contained in this TaxNewsFlash-Canada is of a general nature and is not intended to address the circumstances of any particular individual or entity. Although we endeavour to provide accurate and timely information, there can be no guarantee that such information is accurate as of the date it is received or that it will continue to be accurate in the future. No one should act upon such information without appropriate professional advice after a thorough examination of the particular situation. For more information, contact KPMG’s National Tax Centre at 416.777.8500. KPMG LLP is the Canadian member firm of KPMG, a global network of professional firms providing Audit, Tax, and Advisory services. We operate in 144 countries and have more than 104,000 professionals working in member firms around the world. The independent member firms of the KPMG network are affiliated with KPMG International, a Swiss cooperative. KPMG International provides no client services. KPMG's Canadian Web site is located at www.kpmg.ca © 2007 KPMG LLP, a Canadian limited liability partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International, a Swiss cooperative. All rights reserved.
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